This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers, click the "Reprints" link at the bottom of any article.

February 28, 2013

Iceland Ripe With Opportunity? Maybe

Iceland has come a long way from its nadir, when its three major privately owned banks defaulted on $85 billion in 2008. Thanks to a number of factors, which included tight reins on its currency and steps to protect domestic depositors—an action that somewhat shielded its domestic economy—Iceland has fought its way back to emerge from the crisis, if not stronger, certainly viable. While it still struggles with a number of lingering issues, its economy has grown faster than those of many European countries trying to cope with their own debt crisis.

Most recently, favorable news came in the form of a decision from the European Free Trade Association (EFTA) that the country is not liable for damages in refusing to cover Icebank depositors in the U.K. and the Netherlands during the crisis. The EFTA Surveillance Authority had claimed Iceland violated European Economic Area law in refusing to make good on the deposits, totaling some $5.4 billion in Icesave accounts held by 350,000 British and Dutch citizens, but the EFTA Court in Luxembourg denied the claims, clearing the way for continued recovery.

According to the court’s statement, the laws that govern Iceland’s membership in the European Economic Area failed to “envisage” a “systemic crisis of the magnitude experienced in Iceland.” It added, “How to proceed in a case where the guarantee scheme was unable to cope with its payment obligations remained largely unanswered by the directive.”

Had the verdict gone the other way, the penalty could have been as high as 20% of Iceland’s entire economic output, with the two countries having the right to pursue damages of up to 335 billion kronur ($2.6 billion), as estimated by the International Monetary Fund (IMF). Iceland has already repaid 90% of the money that Britain and the Netherlands had paid out in minimum deposit guarantees to its Icebank depositors, and says that it expects to pay the Icesave claims in full.

Foreign Minister Ossur Skarphedinsson was quoted in reports saying of the decision that it “completely vindicated” Iceland, and added, “Within a few years we will have finished paying all our obligations and probably 15% more than that. I don’t remember any bank in the world that has failed and still delivered results of this kind. So Icelanders will honor their obligations, and that’s what matters most.”

That brought more good news. Based on the EFTA decision, Fitch Ratings lifted Iceland’s long-term foreign currency issuer default rating (IDR) to BBB from BBB-, and Moody’s Investors Service also acted, raising the outlook on Iceland’s Baa3 grade to stable.

According to IMF estimates, while the EU’s GDP is expected to contract by 0.2% in 2013, Iceland’s GDP was projected to grow by 2.3% in 2013. The country’s own central bank had originally expected a 2.9% expansion in 2013, but that estimate has been revised downward a bit, since 2012’s growth proved to be slower than originally anticipated. Still, compared to Europe, Iceland is thriving.

While Napolitano sees private consumption playing a “smaller role” going forward, other elements look to support ongoing growth. “There are some sizeable energy-related investments in the pipeline,” he said, “which are likely to come through in 2014 and will support growth.” This year has its own bright spots: “From the second half of 2013,” he added, “we expect some recovery in the eurozone, and Iceland’s exports will benefit from this. In the longer term, rich natural resources and … good demographics will underpin the growth outlook.”

Iceland has kept its interest rates unchanged in an effort to support its currency—one area where the picture may not be quite so bright. Although the country had begun talks with the EU back in 2010, intending to vote on membership this year, on January 14 the Icelandic government announced that it was putting those talks on hold prior to elections scheduled for April 27.

Membership in the EU could help support Iceland through its common currency. The krona is still under strict controls, to prevent capital outflow, and there have been indications from Iceland’s government and from its central bank governor that the krona may never return to freefloating status.

Napolitano said of the situation, “Given the risks to macroeconomic stability, Iceland’s exit from capital controls will be a lengthy process. Being part of a monetary union would smooth the lift of capital controls as it would eliminate the risk of a sharper depreciation of the ISK and would help keep inflation under control during that process.”